Managers treading lightly as ESG scrutiny grows

Increased scrutiny over just how green investment strategies are has market players worried.

The U.S. Securities and Exchange Commission, European regulators and investors are piling pressure onto money management firms over greenwashing, with the phrase hitting headlines more recently due in part to high-profile allegations made against DWS Group and other firms. As a result, managers are taking a careful look at how they have classified their strategies, with some firms already downgrading their ESG credentials to play it safe and an expectation of more changes to come, sources said.

Increased regulation in Europe has come in the form of the Sustainable Finance Disclosures Regulation, which came into play in March 2021 and was updated with further rules last month. Under SFDR, European Union-licensed money managers must categorize their strategies into one of three classifications: Article 6 — where there are no ESG risks relevant to investment decisions or returns; Article 8 — which promote environmental or social characteristics; or Article 9 funds, which name sustainable investment as their objective.

On top of Europe's regulatory focus is pending information from the Financial Conduct Authority, the U.K.'s financial watchdog, as to how similar rules will be implemented in the U.K. under its Sustainable Disclosure Requirements.

Meanwhile, in the U.S., the SEC has proposed rules that would establish disclosure requirements for funds that are marketed as being ESG-focused.

"At the issuer level and at the fund level, there is more regulation everywhere," said Hortense Bioy, London-based global director of sustainability research for Morningstar Inc. Beyond Europe to places like Hong Kong and Australia, "regulators want to bring greater clarity to the space," she said.

And adding to the regulatory focus is the ongoing investigation into DWS Group, which reached a climax in May with a police raid of the firm's Frankfurt offices over greenwashing allegations. The following day, June 1, CEO Asoka Woehrmann resigned over the allegations, which he said in a statement had become a burden for the €902 billion ($922.2 billion) money manager, himself and his family.

The difficulty is that having an ESG product has become something of an expectation. A money manager without an ESG strategy would probably be skipped over by potential clients, sources said.

"There's been this massive knee-jerk response over the last couple of years that's required asset managers to step up and provide a product" that's labeled as ESG, said Cara Williams, global ESG strategy lead, wealth management and multinational client lead for wealth at Mercer LLC in London. "They don't want to miss out. So it doesn't surprise me that, all of a sudden, you've got products that are not as ESG as they're supposed to be or are simply being misrepresented. In this case, the cart was put a little bit before the horse for some shops," Ms. Williams said.

While having those magic three letters — ESG — somewhere in the investment prospectus of a money manager's funds is a basic requirement for some institutional investor clients, increased demands from regulators and differing implementation rules within regions is adding to managers' stress levels and making some question just how they can keep everyone happy but at the same time keep out of trouble with regulators, sources said.

"It's becoming increasingly difficult to operate effectively in multiple jurisdictions," said Jonathan Doolan, Paris-based managing partner at asset management strategy adviser Indefi Group. "There is SFDR initial taxonomy, Articles 6, 8 and 9 … but (managers are) realizing they can be 8 and 9 (compliant) but cannot promote their funds in certain countries throughout Europe as they have more stringent expectations or qualifications. It's creating a lot of concern and consternation around how can we truly not be accused of greenwashing in some way because at some point there is an element of subjectivity tied to what matters and what doesn't" in certain countries, Mr. Doolan said.

Concern over getting the classification of strategies correct is leading to particular "caution" among money managers, said Chris Redmond, London-based head of manager research at Willis Towers Watson PLC.

"There's a debate around, we've got a fund, it has positive impact, is it Article 8 or 9? I think there is a growing resistance to sign up to Article 9 as people feel they are putting themselves in the spotlight. The unintended consequence of that is Article 8 has become a catch-all for lots of stuff. (It) has become quite watered down and broad — and I think we got there through some of the fears around greenwashing," he said.

Sources agreed that the increased regulatory focus plus allegations of greenwashing are causing money managers to revisit their self-appointed green credentials.

"I think there's a bit of quietness oriented around the fact that everybody is going back to their lawyers or compliance and asking, 'what is our potential risk?'" Indefi's Mr. Doolan said.

That's manifested in some cases as a manager reclassification of funds to Article 8 — so-called "light green" — from Article 9, known as "dark green" for being the most strict category.

Morningstar's second-quarter data show that 16 strategies were downgraded to Article 8 from Article 9 over the three months ended June 30. The firm identified no downgrades to Article 6 from Articles 8 or 9.

Strategies are still being upgraded across the three classifications, Ms. Bioy said, but added that "we can expect more downgrades, more likely from (Article) 9 to 8."

"We have also seen a handful of funds that removed ESG from the name. It is indicative of asset managers wanting to be more cautious given the current regulatory environment. More than ever now, asset managers are cautious about the name they have given their funds," Ms. Bioy said.

The changes have not gone unnoticed across the industry. "When (Articles) 8 and 9 regulation came out, a lot of managers went for 8," said Matthias Fawer, Zurich-based senior ESG and impact analyst at Vontobel Asset Management. "When greenwashing allegations started popping up, more managers were saying, take it back to an Article 6 fund, and let's see how this evolves. I've heard of some fund managers deleting the 'ESG' or 'sustainability' from their fund name" and waiting to see what happens with further rules, Mr. Fawer said. "There's a separation of managers that feel comfortable and others that say it's too delicate and too difficult."

Vontobel, which runs two impact funds that are both registered as Article 9 under SFDR, has made further, recent moves to integrate ESG throughout the firm. In January, Tadas Zukas joined as global lead, senior legal counsel sustainability/ESG. He is "a specialized legal counsel with regulatory expertise and experience in ESG and tackling greenwashing," Mr. Fawer said.

One of Mr. Zukas's first contributions to the firm was to run ESG-awareness training, "covering greenwashing risk and how to communicate ESG. That brings us to another level in terms of trust and reputation. I just went through it and it was really helpful for me, even as an ESG specialist," Mr. Fawer said.

Regarding the reason for hiring Mr. Zukas, Mr. Fawer said executives "have to be aware of what's going on and what we can state in our prospectus and marketing material, and what we really do. We have lots of experience with ESG, but now with (SFDR), it's really all about walking the talk and to be honest with clients and tell them what you do in a transparent way," Mr. Fawer said.

Vontobel AM had 118.3 billion Swiss francs ($123.9 billion) in AUM as of June 30.